I recently watched the show Britain's Spending Secrets, in which the always-good-value Ann Robinson probed into the differing financial habits of different levels of UK society. It was a really good piece of journalism, I thought, which didn't shy away from asking some pretty difficult questions of the people featured.
My favourites were the family (I'll call them the Joneses) who bought a £190 pair of Tiffany sunglasses for their 14 year old daughter. Accompanying the Joneses on their spending spree was the mother of another family (The Smiths), who lived on a third of the income of the Joneses and yet was overpaying her mortgage diligently every month.
When informed of this, Mrs Jones scoffed and said to Mrs Smith words along the lines of: “A mortgage is a mortgage. My mortgage company won't get a penny more out of me; I'm going to enjoy my money.”
At this point I nearly took off my shoe to throw at the TV. But then I realised that her astonishing level of financial ignorance isn't astonishing at all; it's normal. Wrong, but normal.
I'll explain.
Mrs Jones thinks that overpaying a mortgage means giving more money to her mortgage lender. If you look at just the monthly payment then it does indeed mean that, but what about over the term of the mortgage?
If you have a £100,000 repayment mortgage with an interest rate of 3.5% and a term of 25 years, you can expect to pay back £150,300 in total at £501 per month.
But if you overpay by £200 per month, you will pay your mortgage off in 15 years and 5 months, and save about £20,700 in interest.
Credit to MoneySavingExpert for this chart. Click here for their excellent mortgage overpayment calculator
So by overpaying, you pay your mortgage lender less, not more. £20,700 less!
Mrs Jones would doubtless say that she might be dead in 15 years time and she could have got enjoyment out of that extra £200 per month being used to pay down the mortgage. It's her money, and she can do whatever she wants with it.
But to scoff at Mrs Smith for being financially savvy made me both cross and sad. Cross at her arrogance in assuming her way of managing her money was somehow superior to that of Mrs Smith, and sad that she didn't understand the compelling mathematics of overpayment.
I have a feeling that one day, Mrs Smith will be the one enjoying the freedom of being debt free, while Mrs Jones will still be working, to pay off her debt and buy nice stuff for her daughter.
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